Consolidating, Validating And Recalibrating

by: Rising Dividend Investing

A number of different worries have rattled the market to start 2014. Let’s take a closer look at what they are and what each of them means for the global economy and markets.

1. Housing Slowdown

Housing represents a very large part of the U.S. economy (about 20%), which is why economists and investors alike pay close attention to housing data.

After a strong 2013, the housing market data has weakened. New home construction surged in November 2013, but fell in December 2013 and January 2014. Rising interest rates are likely to blame. Mortgage rates have risen to 4.5% from their lows around 3.5% in early 2013. The threat of rising interest rates in 2014 and 2015 has investors concerned that the weakness in housing may continue.

The lull we are seeing in the data could be a result of last year’s low rates, which likely pulled forward some purchases that may not have ordinarily occurred until six months to a full year later. The abnormally cold winter may also be impacting the data. Bad weather keeps potential buyers indoors, homes off of the market, and building projects on hold.

At this point, it is difficult to find anything conclusive from the data. Despite December’s decline, home construction starts are still at their highest annual total since 2007. The only thing we can know for sure is that the housing industry is much stronger than it has been in many years. There is still reason to believe it could be a positive contributor to the economy in 2014.

2. Disappointing Labor Data

January’s employment numbers presented another opportunity for investors to worry. Total nonfarm payroll employment rose by 113,000 workers in January, which left the unemployment rate changed at 6.6%. January’s data marked the second month in a row of less-than-expected job growth.

The report was disappointing, but it also provided a couple reasons to be optimistic about the future:

  • Despite one of the coldest Januaries on record, the number of new construction-related jobs in January 2014 was nearly double what it was in January 2013. Residential construction had a strong 8.8% year-over-year increase. Both numbers confirm continuing improvement in one of the economy’s most critical components.
  • Since 2009, the number of Americans actively searching for jobs has steadily fallen. In January, the labor force reportedly increased by 500,000 workers – bumping the participation rate up to 63% from 62.8% last month. If this trend continues, it is more evidence of a strengthening economy.
U.S. Participation Rate (source: Bureau of Labor Statistics)

3. Emerging Markets Concerns

On top of weakening U.S. data, investors have been dealing with the so-called “Fragile Five” emerging market nations of Indonesia, Brazil, Turkey, South Africa and India.

These countries have large current account deficits so they rely heavily on external financing from foreign investors. Over the past several years, monetary stimulus from the Fed has provided more cash for investors and increased investment into these countries. As Quantitative Easing (QE) starts to come to a close, currency traders have started pulling money out of the F5’s currencies.

To combat devaluing currencies and attract investors, F5 central banks raised interest rates. The problem is that these higher rates crush local consumer demand, which is exactly what these countries have been working towards creating. Internal demand is also what attracts Western companies and investors.

While these countries only represent about 7% of the world’s GDP, investors feared that the crisis in the F5 markets could spark larger economic slowing – similar to the Asian financial contagion in 1997.

However, other emerging market nations are much stronger than they were in 1997. China appears to have stabilized its economy at about 7% GDP growth. Europe is looking stronger. Japan seems to have solved their deflationary issues, at least for the time being. As a whole, the global economy is in better shape than it was, even 12 months ago. The situation in the Fragile Five seems to be isolated, so we don’t see it as a major threat to continued economic improvement.

What’s Happening in the Market?

The worries have been enough for some analysts to scale back their growth expectations for 2014. As investors re-calibrated these new expectations into their models, we saw the market pullback 5.8% from its January highs. Many investors sought the safety of “riskless” assets, which caused the 10-year U.S. Treasury bond yields to fall from 3.0% to start the year to below 2.6% in early February.

Over the past week, the market has nearly fully recovered from the modest pullback and interest rates have risen back above 2.75%. Until additional data validates the direction of the economy, however, we expect continued volatility in the markets.

What Does It Mean for You?

At DCM, we are still cautiously optimistic about 2014. We expect interest rates will continue to rise modestly in 2014 and into 2015. With the stock market about fairly valued, long-term growth rates for the market should be about equal to dividend and earnings growth.

The modest pullback provided some opportunities to top off stocks that had fallen to good technical levels, but – as we mentioned last week – we don’t anticipate making any major changes. We believe our portfolios are well-positioned to protect on the downside with higher-yielding B and C stocks, while the higher-growth A stocks provide plenty of upside if the economy continues to improve as it has. And, as always, we will continue to look to the dividend as our guide in these volatile conditions.